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Stance of Monetary Policy for the Second Half of 2002-03

42. The annual policy Statement of April 2002 had indicated that under normal conditions and barring emergence of any adverse and unexpected developments in the various sectors of the economy, the overall stance of monetary policy for 2002-03 will be:

Provision of adequate liquidity to meet credit growth and support investment demand in the economy while continuing a vigil on movements in the price level.

In line with the above, to continue the present stance on interest rates including preference for soft interest rates.

To impart greater flexibility to the interest rate structure in the medium-term.

43. Monetary management in the first half of 2002-03 was largely in conformity with the monetary policy stance announced in the annual policy Statement of April 2002. As spelt out in the policy Statement, RBI has been able to maintain a stable interest rate regime throughout the first half of the year with a bias towards softening of interest rates. The yields on government securities in the secondary market ruled much lower than the yields at the beginning of the financial year. Nearly two-thirds of the market borrowing programme of the Government could be completed at a lower cost, with longer maturities, without any adverse impact on the general interest rate structure.

44. Commensurate with some visible signs of revival in industrial activity and an upturn in the export sector, there has been a substantial pick up in non-food credit which is expected to continue in the remaining part of the year. The growth in infrastructure industries is expected to boost industrial activity with a lag and as such, the index of industrial production this year may be higher than what was expected at the beginning of the year. However, the delayed monsoon and its subsequent impact on agricultural production may slightly dampen rural demand for both durable and non-durable goods. Nevertheless, as exports are buoyant, the outlook for industry seems to be better than it was last year.

45. At the short end of the market, the average call money rate came down sharply from 6.82 per cent in early April to 5.74 per cent by October 2002. During this period, the LAF repo rate was also brought down from 6.0 per cent to 5.75 per cent. The CRR was reduced by 50 basis points to 5.0 per cent effective June 1, 2002 augmenting lendable resources of the banking system by Rs. 6,000 crore. The interest rates in other money market instruments also declined. For example, the primary yield on 91-day Treasury Bill declined by 41 basis points from 6.13 per cent to 5.72 cent between April and October 2002. During the same period, the primary yield on 364-day Treasury Bill and the yield on government securities with residual maturity of 1-year declined by 42 and 30 basis points, respectively. At the longer end, the secondary market yields on government paper in the maturity range of 10 to 20 years have softened from 7.37 - 7.91 per cent in April to 7.07 - 7.63 per cent by October 2002.

46. The softer interest rates prevailing in the economy in the recent period, is sustainable in the medium/long term if the rate of inflation continues to be low. An important objective of monetary, fiscal and supply management policies must be to ensure that there is no resurgence of inflationary pressures in the economy.

47. The Reserve Bank has taken significant steps towards deepening and widening of the government securities market, both in its primary and secondary segments, in recent years. These include elongation of the maturity profile in bond issuances, retailing of government securities through non-competitive bidding, and introduction of uniform price auctions on an experimental basis. The maximum maturity was gradually elongated from 20 years during 1998-99 to 30 years in 2002-03. Simultaneously, the weighted average maturity has increased substantially from 5.7 years in 1995-96 to 14.26 years in 2001-02. On the other hand, the average cost of issuance has come down from 13.75 per cent to 9.44 per cent over the same period. Further, certain innovations were also introduced through instruments like floating rate bonds and allowing put/call options in government securities. On the basis of the experience gained so far, RBI will consider issuance of such innovative products more frequently, depending on market conditions.

48. Recognising the fact that a substantial portion of deposits with banks is in the form of long-term deposits at fixed interest rates, the annual policy Statement of April 2002 had urged banks to introduce a flexible interest rate system for new deposits while continuing to make available the fixed rate option to depositors. The available information from banks suggests that banks are making efforts in this direction. The policy Statement had also urged banks to devise schemes for encouraging depositors to convert their existing long-term fixed rate past deposits into variable rate deposits. It is expected that such efforts would, over time, enable banks to reduce to some extent, the downward inflexibility in the interest rate structure.

49. The annual policy Statement of April 2002, stressed customer protection and transparency in regard to actual interest rates to depositors and borrowers. It urged banks to review the maximum spread over PLR and reduce their interest rates wherever unreasonably high so that credit could be available to borrowers at reasonable interest rates. Accordingly, RBI in consultation with banks, prescribed an information system on maximum and minimum interest rates charged to borrowers. According to the available information, there has been some reduction in the maximum and minimum interest rates charged by banks. The information would be put on the RBI website, as soon as the data system gets stabilised.

50. The measures to encourage greater flexibility in domestic deposit rates, reduction of spreads over PLR and transparency in the range of interest rates charged, apart from generating healthy competition among banks, are expected to improve banking facilities available to depositors and make them more responsive to changes in the overall financial and inflationary environment. The Reserve Bank will be pursuing these issues further and welcomes any suggestions in this regard.

51. In the current financial year so far, the forex market showed considerable stability without any undue pressure on the exchange rate. The Reserve Bank will continue to follow the same approach of watchfulness, caution and flexibility in regard to the forex market. The Reserve Bank will also endeavour to ensure that the quantum of reserves, as far as possible, is in line with the growth rate in the economy, the share of the external sector in the economy and the size of risk adjusted capital flows.

52. Consistent with price stability, RBI will continue to ensure that all legitimate requirements for credit are adequately met. Towards this end, RBI will continue its policy of active demand management of liquidity through Open Market Operations (OMO) including Liquidity Adjustment Facility (LAF), and using the policy instruments at its disposal as and when the situation warrants.

53. The outlook for industrial growth and exports during the year 2002-03 remains positive. In this scenario coupled with a moderate level of global inflation, the inflationary outlook for the domestic economy continues to be favourable. The Reserve Bank, therefore, proposes to continue with the overall stance of monetary policy announced in the April policy Statement for 2002-03 for the remaining half of the current year.

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